236 PART ONE MANAGEMENT ACCOUNTING, INFORMATION AND DECISIONS

236 PART ONE MANAGEMENT ACCOUNTING, INFORMATION AND DECISIONS

EX H I B I T 5 B - 1

CU STO M TOTAL EASTCLO CK

STAN DARD

D ELU XE

Volume (units)

$525,000 $4,200,000 Income Statement for

CO RPO RATIO N

the Year Ended

VARIABLE COSTS:

Total variable costs

Contribution margin

FIXED COSTS: 2

Quality control 2 65,000

Other manufacturing

Total fixed costs

Net income

N OTES :

1. It has been reliably determined that variable overhead is a function of direct labour dollars. 2. Fixed manufacturing overhead (Engineering, Quality Control, and Amortization) is allocated to prod-

ucts based on their relative proportion of total direct labour dollars.

3. Other fixed manufacturing overhead and fixed selling and administrative expenses are allocated to products based on the relative volume of units sold.

Fu rth er discu ssion s took place with th e produ ction people, in clu din g repre- sen tatives of en gin eerin g, qu ality con trol, an d th e m ach in in g an d assem bly departm en ts. In terviews also took place with represen tatives of th e m arketin g an d adm in istrative departm en ts. A su m m ary of th e h igh ligh ts of th ese discu s- sion s follows:

Karl Bech told (En gin eerin g Departm en t): “Ou r n ew com pu ter-assisted design system h as really ch an ged th e way we do th in gs arou n d h ere. Wh en an order com es in , it is tagged as bein g eith er stan dard, delu xe, or cu stom . I’d gu ess th at 75 percen t of ou r tim e is spen t on th e cu stom orders as th ey u su ally requ ire sign ifican t adaptation s. I’ve poin ted th is ou t to th e accou n tin g people on several occasion s, bu t th ey seem pretty tied u p lately with th eir n ew com pu ter. Th e stan - dard m odel requ ires ou r atten tion from tim e to tim e bu t I’d gu ess th at it’s on ly abou t 5 percen t. Revision s to th e delu xe m odel are a little m ore com plicated an d take u p th e rem ain der of ou r efforts du rin g th e average m on th . If we were to retu rn to m ore n orm al levels of produ ction for th e th ree produ cts, I’d gu ess th at we wou ld spen d abou t h alf of ou r tim e on th e cu stom orders an d split th e rem ain in g h ou rs between th e oth er two lin es.”

Harvey Ram soom air (Qu ality Con trol): “Noth in g leaves th is plan t th at isn ’t strictly to ou r cu stom ers’ specification s. It m ay n ot be wh at th ey wan ted bu t it’s gu aran teed to be wh at th ey ordered. Th is sort of qu ality assu ran ce is on ly possi- ble by carefu lly m on itorin g th e qu ality of ou r raw m aterials an d th e produ ction process. We ch eck th e ou tpu t of th e work cen tres wh en th ey begin each job an d m on itor ou tpu ts ran dom ly. Given th at th e stan dard an d delu xe m odels are pro- du ced in large batch es, I’d gu ess th at th ey each cu rren tly take abou t 20 percen t

Chapter 5 Cost Allocation and Activity-Based Costing Systems

Fran Sprocket (Su pervisor Mach in in g & Assem bly): “Th is n ew com pu ter- aided m an u factu rin g equ ipm en t h as really ch an ged ou r m an u factu rin g proce- du res. I can rem em ber ju st a few years ago h ow we h ad to carefu lly m on itor each operation . Now, on ce we get th e th in g set u p, all we h ave to do is m on itor th e ou tpu t. Th is m ach in ery is very expen sive. Th e an n u al depreciation on th e m ach in ery is $230,000 for each of th e produ ct lin es. I’ve n ever u n derstood wh y th e accou n tin g system ch arges so little depreciation to th e cu stom lin e given th at we in vested a lot in th e m ach in ery to accom m odate th ese special orders for cu s- tom ers. Th e costs th at are labelled as “oth er m an u factu rin g” in th e accou n tin g reports seem to relate m ostly to th e volu m e of goods produ ced an d sold. My biggest problem is sch edu lin g th e assem blin g h ou rs. Th e ph ysical layou t of th e plan t restricts th e am ou n t of assem bly space an d, th erefore, th e n u m ber of h ou rs th at I can sch edu le. Th e m axim u m n u m ber of assem bly h ou rs is 70,000 an d n oth in g can be don e to in crease th is in th e n ext 12 m on th s.”

Steve Won g (Marketin g): “I don ’t feel th at th ere is an y problem with th e costin g system as far as m arketin g expen ses are con cern ed. Th e am ou n t of tim e, en ergy, an d expen se devoted to each of th e produ ct lin es seem s to depen d on th e volu m e of orders sold. Th e big problem I h ear abou t from th e salespeople cen tres arou n d ou r prices. We’re ru n n in g abou t $5 above ou r com petitors on th e stan - dard m odel an d th is is really cu ttin g in to ou r volu m e. If we cou ld ju stify a m ore com petitive price, I expect sales wou ld ju m p to a m ore n orm al level of 74,000 u n its per year. We cu rren tly base all of ou r prices on a 50 percen t m ark-u p over variable costs an d th en rou n d off to th e n earest dollar.

“My people are glad to see th ose cu stom orders rollin g in . It’s h ard to fin d ou t wh at ou r com petitors are ch argin g for sim ilar work bu t th ere is som e evi- den ce to su ggest th at ou r prices are way ou t of lin e com pared to ou r com petition . Th e strategy of th e com pan y is to m arket th e stan dard an d delu xe m odels an d offer th e cu stom m odel as a service to regu lar cu stom ers at a prem iu m price. As

a resu lt, we wou ld n orm ally sell abou t 1,000 cu stom u n its per year, wh ich is th e level we operated at several years ago. With respect to th e delu xe m odel, I feel th at th e cu rren t price is m ore or less correct an d, th u s, we expect th at volu m e will rem ain at cu rren t levels for th e foreseeable fu tu re.”

Ton i An derson (Vice Presiden t): “We’ve got to tu rn th is situ ation arou n d or we’ll h ave to sell ou t. Th e boss says h e’s been gettin g som e pretty attractive offers from som e Am erican tool-an d-die firm s. I’d h ate to see u s sell ou t with ou t a figh t because I think we’ve got a responsibility to our employees— some of whom have been with us since high school. The bottom line is each product should cover its own costs and earn at least a profit margin of 10 percent before taxes this year.”

Required: Assume the role of the outside consultant. Prepare a report addressed to the man- agement of Eastclock Corporation that clearly identifies and analyzes the issues it faces, and make specific recommendations for improvement. Also include a pro forma income statement for 2002 that incorporates your recommendations.